Tax Impact of the Paycheck Protection Program

The Coronavirus Aid, Relief and Economic Security Act (the CARES Act) created the Paycheck Protection Program (PPP), pursuant to which certain taxpayers are eligible to obtain low-interest loans to enable continued operations during the coronavirus pandemic. If a taxpayer spends the PPP loan on certain enumerated expenses, including, among other things, payroll costs and rent, all or a substantial portion of the PPP loan will be forgiven. Participation in the PPP, however, has some critical tax impacts that should be considered. Below is a summary of some of such tax impacts:

With respect to taxpayers that receive a PPP loan:

A taxpayer that receives a PPP loan is ineligible to claim the employee retention credit, which is a refundable payroll tax credit also established by the CARES Act.

With respect to taxpayers that have a PPP loan forgiven:

In Notice 2020-32, the IRS announced that no tax deductions will be allowed for expenses that are funded by PPP loans that are later forgiven. As discussed above, forgiveness is available only if the taxpayer spends the PPP funds on certain enumerated expenses: payroll costs, mortgage interest, rent, and utilities. To obtain forgiveness of 100% of the loan, at least 75% of the PPP funds must be spent on payroll costs; the remaining 25% can be spent on the other enumerated expenses. (Note that to qualify for forgiveness the taxpayer also must satisfy certain employee retention standards.) Generally, these items are all deductible expenses. Under the IRS guidance, if a taxpayer uses PPP funds for these expenses and the taxpayer’s PPP loan is later forgiven, the taxpayer is not eligible to deduct any such expenses.

The IRS is taking the position that the PPP funds essentially constitute income that is exempt from tax. Section 265(a)(1) of the Internal Revenue Code provides that no deduction is allowed to a taxpayer for any amount otherwise allowable as a deduction if such deduction is allocable to tax-exempt income.

Many members of Congress, including Senate Finance Committee Chair Chuck Grassley, have publicly stated that the IRS’s position in Notice 2020-32 is contrary to the legislative intent of the PPP. In addition, a number of professional organizations, such as the AICPA, have issued statements requesting that Notice 2020-32 be rescinded or overruled by legislative action. Furthermore, many practitioners have argued that Notice 2020-32 is inconsistent with the Internal Revenue Code and the CARES Act. As a result, the position set forth in Notice 2020-32 may be reversed by legislative action, further IRS guidance, or a court ruling.

The amount of the forgiven loan is not considered cancellation of indebtedness income that is subject to tax. Accordingly, forgiveness of the loan should not result in any negative federal income tax consequences (other than the disallowed deductions discussed above).

Once a taxpayer has a PPP loan forgiven, the taxpayer cannot defer any subsequent payments of payroll taxes. Generally, taxpayers are eligible to defer until December 31, 2021 50% of payroll taxes with respect to social security taxes and FICA taxes attributable to the period March 27, 2020 – December 31, 2020, the remaining 50% can be deferred until December 31, 2022. Deferral ceases if and when the taxpayer’s PPP loan is forgiven.

We are continuing to monitor legislative actions and IRS guidance for any additional updates that address the tax impact of the PPP, including in particular with respect to the deductibility of expenses funded by PPP loans that are later forgiven. So stay tuned!